Australia: Everything You Need To Know About The Australian Domestic Gas Security Mechanism—What Does This Mean For Australian LNG Exporters And Corporations Importing From Them?

The Australian Domestic Gas Security Mechanism at a Glance

On June 5, 2017, the Australian government released draft
amendments to the existing Customs (Prohibited Exports) Regulations
1958 (the "Amended Regulations") that proposes a
mechanism (the Australian Domestic Gas Security Mechanism or ADGSM)
that calls for liquefied natural gas (LNG) export control
restrictions in circumstances where the Resources Minister
reasonably believes that there will not be sufficient gas supply
for the Australian domestic market in any given year.

The ADGSM – When and Why?

The ADGSM is expected to be effective from July 1, 2017, with a
five-year sunset clause (until January 1, 2023). There will be a
review in 2019 to assess the overall effectiveness and efficiency
of the ADGSM against its stated objectives.

The ADGSM is designed to be a short-term, targeted solution to
ensure security of the gas supply at an affordable price. Many have
seen this as a response to national energy security concerns as a
result of the surging domestic gas price in Eastern Australia,
evidenced by an 80 percent price increase over the past 18 months.
LNG exporters drawing gas (in net terms) from the domestic market
are therefore required under the ADGSM to limit export or find
offsetting sources of new gas.

The Declaration – Consultation – Determination
Process

Under the ADGSM, LNG export restrictions will be imposed in only
a "domestic shortfall year." In order to arrive at such a
conclusion, the Resources Minister will have to:

formally issue a declaration to
announce his/her intention to consider whether the forthcoming year
will be a domestic shortfall year (the
"Declaration")

consult relevant market bodies,
government agencies, potentially impacted industry players, other
relevant Australian government ministers and other stakeholders to
seek their view on the then-current and forecast gas market
conditions and any potential for a gas market shortfall (the
"Consultation")

if he/she has reasonable grounds to
believe that there is a domestic gas market shortfall after the
Consultation, make a determination that gas export controls will
apply in a particular year (the "Determination").

The Declaration – Consultation – Determination
process follows a statutory timeline. The Declaration should be
issued before October 1, and the Determination has to be made no
later than November 1 of the year preceding the domestic shortfall
year.

Export Permissions in a Domestic Shortfall Year – the
Licensing Regime

In any given domestic shortfall year, export controls will
apply. Under the ADGSM, this means that LNG export activities are
prohibited across Australia (even though the shortfall exists in
only certain parts of the country) without an Export Permission. An
Export Permission will take the form of either an Unlimited Volume
Export Permission (a "UV Permission") or an Allowable
Volume Export Permission (an "AV Permission").

UV Permission. This will typically be
granted to an LNG project that is a net contributor to the domestic
gas market and that is unable to deliver gas at a reasonable price
to a market experiencing a shortfall. A UV Permission allows for
the export of an unlimited volume of LNG from a particular project
over the market shortfall year.

AV Permission. This will typically be
granted to an LNG project connected to markets experiencing a
shortfall, including an LNG project that is in net deficit to the
domestic gas market. An AV Permission will set a maximum LNG volume
that can be exported from a specific project over the market
shortfall year. The maximum amount would customarily represent the
difference between the in-net-deficit exporter's forecast total
export quantity and its allocated share of/contribution toward the
gas shortfall amount to be met by export controls as determined by
the Resources Minister under the ADGSM.

Net Market Position of an LNG Project.
In any given domestic shortfall year, the Resources Minister will
determine whether each LNG project is a net contributor to, or in
net deficit to, the domestic gas market, based on its upstream
tenements. According to this classification, different LNG projects
will be entitled to a different type of Export Permission in such a
domestic shortfall year. An LNG project is in net deficit if:

its total gas used is greater than
the sum of gas produced by upstream tenements (i) owned by the LNG
project, (ii) owned by the LNG project or third parties and is
contracted directly to supply the LNG project and primarily
developed for exports purposes, and (iii) owned by third parties
and is contracted directly to supply to the LNG project and the
contract was entered into before a final investment decision was
made in relation to that LNG project or

its gas purchases from the domestic
market are greater than its gas sales to the domestic market.

Conversely, if an LNG project is not in net deficit, it will be
regarded as a net-contributor LNG project.

Enforcement of the Licensing Regime Under the ADGSM

Under the Amended Regulations, noncompliance with a condition of
an Export Permission may lead to a revocation of the Export
Permission. Alternatively, the Resources Minister may grant a
replacement Export Permission with different conditions attached,
such as granting a lesser LNG export volume or imposing a stricter
information reporting requirement.

Implications for Australian LNG Exporters

The ADGSM is of
nationwide application. If a given year is determined
to be a domestic shortfall year, all LNG exports
will be prohibited, unless exported in accordance with an Export
Permission, and all in-net-deficit LNG projects
will be allocated a gas shortfall amount that will be counted
toward the reduction in the allowable LNG export volume in the
relevant exporter's Export Permission. As such, an
in-net-deficit exporter located in a gas surplus region (e.g.,
Western Australia) will still be affected, since the ADGSM will
impose on it an obligation to offset a portion of the country's
gas shortage amount to be met by export controls. Conversely, if an
LNG exporter is classified as a net contributor, regardless of
where it is situated geographically, it is still very likely to be
granted a UV Permission and therefore can export an unlimited
volume of LNG from gas produced from its upstream tenements even in
a domestic shortage year.

The Rise of Resource
Nationalism. The ADGSM follows a new wave of resource
nationalism around the Asia-Pacific region in the name of national
energy security. Earlier this year, Indonesia banned exports of
unprocessed copper ore in a mining dispute, and the Philippines
restricted open pit mining and curbed nickel ore shipments. It
remains to be seen whether the ADGSM will be an effective means to
deal with the gas shortage in Australia or whether it would be a
mechanism adding complications and uncertainty to the Australian
domestic gas market. The enforcement of the ADGSM also has some
clear World Trade Organization (WTO) and Australia-U.S. FTA angles,
since countries are generally prohibited under these trade rules
from restricting imports/exports except through duties. While
(albeit limited) exceptions do exist in the WTO for purposes of
preservation of natural resources and ensuring domestic supply,
with respect to the former, there is recent WTO case jurisprudence
(e.g., China—Measures Related to the Exportation of Rare
Earths, Tungsten and Molybdenum (WT/DS431-433)) that make clear
that such restrictions are permissible only if there are also
effective restrictions imposed on domestic production and
consumption. With respect to the latter, countries would
essentially have to establish that the restricted products are
"critical" to the exporting country and that the
restrictions are "temporary" for the stated purpose only.
Finally, while the ADGSM hints at potential national security
concerns, it is unclear whether this is, in fact, an argument being
put forward by the Australian government, since such
positions—while mostly self-judging—will only encourage
other trading partners to arbitrarily invoke the same with respect
to certain of their export products.

Wide Government
Discretion in the Decision-Making Process. The ADGSM
contains two decision points: the Resources Minister's
determination that (i) a particular calendar year shall be
classified as a domestic shortfall year, and (ii) an Export
Permission shall be granted to a particular LNG exporter during
such a domestic shortfall year. In each case, even though the
Resources Minister is obliged to consult various stakeholders in
the industry and across the government within certain statutory
time frames, he/she has considerable discretion during the
decision-making process. The consultation period may be as short as
30 days before the Resources Minister can formally announce such
radical export control measures with far-reaching
implications.

Ability for LNG Projects
to Adjust Commercial Operations in Response to Government
Decisions. Under the ADGSM, the Declaration process
will be made prior to October 1, and the Determination process will
be made no later than November 1 of the year preceding the domestic
shortfall year. In addition, the Resources Minister may, at any
time, revoke his/her decision that a particular calendar year is a
domestic shortfall year. LNG projects may not have sufficient time
to adjust commercial operations around these government
decisions/determinations, which may eventually lead to an even more
volatile gas market domestically.

Implications on LNG
Supply Obligations Under Long-Term Offtake
Arrangements. Most Australian LNG volumes are
exported under long-term supply contracts, where failure to supply
in a non-force majeure scenario triggers a seller obligation to
procure replacement LNG cargoes with incremental costs borne by the
seller. Although "acts or omissions of a Government
Authority" are often within the scope of a "force
majeure" event, a failure to supply resulting from the lack of
economically recoverable reserves from a seller's upstream
tenements would (under most long-term LNG supply contracts)
disqualify a force majeure argument. This suggests that a force
majeure argument would be difficult to raise in response to an
export restriction imposed under the ADGSM, meaning that any LNG
exporters that cannot meet their LNG export obligations will need
to procure replacement LNG cargoes and incur any incremental
replacement costs. How significant these shortfall amounts will be
as a result of the application of the ADGSM remains to be seen, but
some analysts have suggested that the impact will be limited to
Australian suppliers having to buy just one or two additional
cargoes a year to make up the shortfall.1

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